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8 shares to play the infrastructure boom

Experienced investor David Kempton reveals two construction stocks he bought recently and six that are on his watch-list.

 
8 shares to play the infrastructure boom

Improving the country’s infrastructure is a hot topic right now and that’s got me thinking about my time in international construction as well as the investment opportunities in Britain today.

Sharp practice

After 18 years working mostly for local companies in South America, Middle East and S E Asia I left the industry with some pretty brutal views on the methods employed to win business.

The rules of engagement were:

Quote cost price, profit comes later.
You will never build as tendered so ensure that your control of contract variations is better than the clients, then hit them fast, hard and often – should be one every day.
Charge the client as much as possible, pay your subcontractors as little as possible and normally late.
At about 75% completion point tell the client you can’t finish without renegotiation or you’ll have to leave site.

If that sounds exaggerated, I’m afraid it’s the reality so make sure variations of that approach haven’t filtered down to the people employed on your own kitchen extension! 

Did we need Hinkley?

We must also hope the government is up to the tasking of monitoring the French and Chinese contractors at Hinkley C.

I was always against the nuclear power plant, not just because of the ruthless methods of contractors or even that it seems high risk to go for a system where none of the Areva-designed reactors is yet operating.

My real issue was that the project won’t produce a megawatt before 2025, by which time other systems of power generation and storage will be so much further advanced that we won’t need a generator of this scale on one site.

Looking at the politics of the situation, I have to say I have already benefited in a small way from the backwash of the decision to go ahead. I am chairman of a deep geothermal system at the Eden Project site in Cornwall where we have struggled to obtain suitable government funding. Now we have a Chinese company showing strong interest. Would this have happened without their involvement in Hinkley? Most unlikely. 

The ten-year build will bring a 25,000 workforce to the West Country. Brace yourself Somerset, there’s a lot of Chinese, French and Brits coming your way. By the way, the French have form in the region when they built the second Severn crossing bridge in 1996 at a competitive price the British contractors couldn’t match.

Bulging pipeline

Statistics show that UK construction output has fallen in recent months, but this could change quickly as Philip Hammond ‘resets’ the economy to take on more debt at the cheapest rates ever available to any chancellor.

There are some wonderful landmark projects in the pipeline. In addition to the £18 billion Hinkley deal, there is £50 billion being spent on the HS2 railway, £20 billion on a new runway and terminal at Heathrow and a predicted £20 billion more infrastructure spend earmarked for next month’s Autumn Statement.

I must add that most of the quality contractors in the UK rarely engage in the practices I described earlier. After the Brexit sell-off they look good value and worth considering again at this stage in the cycle.

My short-list

Having trawled through the list of 100 UK’s biggest by revenue, I came out with a short list of eight cheap stocks with good prospects. I bought shares in the first two and have got my eye on the others.
 
Costain (COST): although recently held back by an £11 million provision on a bad contract, the company has a record order book of £3.9 billion, 90% of which is repeat business. The shares trade at 12 times earnings and have a low price/earnings (P/E) to growth ratio (PEG) of 0.6, yield 3.8% from the dividend, backed by £108 million of cash on the balance sheet. With three brokers rating it a ‘strong buy’ I think it’s a compelling case.

With sterling down 20% against the dollar since the EU referendum there is a good chance overseas bidders will swoop on some of the UK’s star performers – like Softbank did with ARM Holdings. 

If you think consolidation could occur in the construction sector then Interserve (IRV) stands out as a bargain at this level.

The company has also had its share of bad news and labours under debt that is equivalent to 60% of its market value. However, as its capital markets day highlighted last week, the group benefits from good geographic spread and high operating margins of 20%. On a P/E of 5.4, a PEG of 0.1 and yielding 7.6% with five brokers on a ‘strong buy’ I was a buyer.
 
That leaves six on my watch list for positive company news and contract awards.

I’m tempted by T Clarke (CTO), which at £27 million is a small company, but whose mechanical and electrical expertise could be very much in demand in future. They did well last year in reducing balance sheet debt from £8 million to positive cash of £1.3 million. A P/E of 8, PEG of 0.4 and 5% yield look attractive.

Steelwork contractors Severfield (SFR) also looks very cheap with a P/E of 11, PEG of 0.3, 3.3% yield and two brokers recommending the shares.

The other four that merit watching are Carillion (CLLN), Kier (KIE), Morgan Sindall (MGNS) and Renew (RNWH), an existing holding I’ve mentioned here before which has shot up 34% since Brexit and deserves a pause for breath.

David Kempton is an experienced investor, proprietor of Kempton Holdings and a non-executive director of a number of quoted and private companies. He may have an interest in any of the investments which he writes about. 

21 comments so far. Why not have your say?

Hotrod

Oct 26, 2016 at 10:26

On the face of it David's analysis looks sound, but the problem is "The Market" not the fundamentals.

My small portfolio is already overweight in the construction sector, I have been sitting here passively watching my investment capital slowly shrinking every day with a fair degree of incredulity. So what is going on ?

Small investors like me do not make the market, we merely follow it. The volumes of our trades are too insignificant to move share prices, so I have been studying what the leading fundsmiths have been buying. I cannot see a clear picture because most funds are comprehensively diversified, but examining their top ten holdings has been quite revealing.

It seems to me that fund managers are not bothered about preserving capital; their main concern is dividend payments. It doesn't matter to them if companies are totally submerged in debt as long as the fund's algorithm programmed computers can regularly and routinely skim off the Wonga, thus ensuring salaries get paid. The effect is therefore, logically, artificially enhanced capitalisations of some companies whilst others are depressed.

With all that said, I take note of David's selections, and live in hope that the market will see an upturn as a result of the Chancellors Autumn Statement.

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Micawber

Oct 26, 2016 at 12:15

The government still has the problem of no money. I doubt that there will be a huge amount of borrowing to fund infrastructure schemes. More likely a continuation of Conservative policy to make the right noises and give approval to infrastructure schemes but not to finance them with public money. Their aim has been, and will be, to get others to fund the schemes. Lately there ahs been talk of inducing pension funds to engage in new infrastructure. International investors will clearly be very wary given the fragility of sterling as the UK boat rocks in Brexit turbulence.

I'm going to wait and see before chucking money into construction and basic materials companies that often are not very efficient. Renew is an exception, but its strong run over the past four years leaves me wondering where additional upside is coming from.

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anglo29

Oct 26, 2016 at 12:48

I too, live in "hope" rather than expectation re. David's comments. There's a year of appeals and legal processes before yet another (final?) decision as to whether the third runway will actually go ahead. HS2 is also clouded in controversy. By the estimated completion time of 2027 we could all well be swanning around in jetpacks! Many might conclude the money would be better spent re-linking up all those small towns cut off from the national rail network by Beeching & Co.

As for Hinckley, with Cameron/Osborne so keen to cosy up to China, it became a difficult one to get out of...What guarantees are there that their own construction companies won't be grabbing the prime contracts?

Meanwhile I'll hang on to my shares in Carillion, mainly for the decent dividend, despite them still being firmly in the red.

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Anonymous 1 needed this 'off the record'

Oct 26, 2016 at 14:58

"I must add that most of the quality contractors in the UK rarely engage in the practices I described earlier. " - Absolute poppycock David. I have been in the industry all my working life, (35+ years), and I can tell you, without exception, ALL major contractors adopt the stance you describe. It's the only way they can generate profits. The only one I have never worked with in my time is Interserve, and they are the only stock in the industry I hold, (or indeed have ever held).

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Nigel James

Oct 26, 2016 at 18:42

I'm with Micawber, there's no public money and I too doubt much will be borrowed to fund infrastructure projects - that's comrade Corbyn's territory. As for more Heathrow, it'll never happen, at least not in my lifetime. The decision is political, not practical, blah blah. It'll be mired in legal challenges, protests (sans Boris lying down in front of bulldozers, which is also never going to happen) and horse trading for the next 25 years. Cloud cuckoo land.

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col lord

Oct 26, 2016 at 20:02

Easy for the Theresa May Govt. to showcase this pipedream to show how tough they are, but none of them will still be in office when the first speculative brick isnt laid.......lets hope they dont waste too much of our money on their special committee buddies etc........

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Hugh M

Oct 27, 2016 at 04:39

Why, oh why buy construction companies which you may think will benefit from infrastructure products in one region, particularly UK? You can buy shares in many of them globally via an infrastructure fund and reap the benefits of projects worldwide.I bought such a fund at the end of May and in 5 months it is up more than 22% plus dividends. (3% better than my Fundsmith holding)

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Nigel James

Oct 27, 2016 at 10:25

Which, Hugh?

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Hugh M

Oct 28, 2016 at 05:51

Hi Nigel.

First State Global Listed Infrastructure B GBP Inc.

I understand that most IT's have a hefty premium but this doesn't occur with UT's and OEIC's.

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Nigel James

Oct 28, 2016 at 09:54

Thanks Hugh, I'll look into it.

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Michael Grimes

Oct 29, 2016 at 11:10

Looked at First State on HL and surprised by the difference between Class A and Class B income or accumulation and hedged unit prices and history etc. Any explanation would be most welcome ! I naturally look at the lowest unit price ie class B accumulation hedged GBP but these seem to have dropped and A units twice the price have risen and get HL recommendation. What am I missing?

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Neil Gardner

Oct 29, 2016 at 11:24

It's a pity Kempton can't get his facts right, is he one of these dreaded "analysts" who is always surprised when they get it wrong. The Second Severn crossing was built by a UK/French civil engineering consortium. Similarly Hinckley will be built by a consortium with UK civils contractors building the main infrastructure, the Chinese do the specialist section. EDF will sit there as the Client and let everybody else do the work.

At least Civil Engineering is getting a mention !!!

hinckley

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Christopher

Oct 29, 2016 at 13:16

Why don't we crowd fund a bulldozer (Ukip can advise us on crowdfunding, even put in the £10 they raised) and drive it up and down near Harmondsworth and let Boris think that we are building runway 3?

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anglo29

Oct 29, 2016 at 19:08

Who's going to pay for damage to the bulldozer?

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Hotrod

Oct 29, 2016 at 20:36

The Washington Post reports that Elon Musk via Tesla Electric Cars has agreed to buy a near bankrupt solar panel company. Solar City Inc.

The company is able to demonstrate its products as fitted to a film studio in Los Angeles.

Their U.S.Ps. are that the panels mimic traditional roof tiles although made of glass and fit directly onto the woodwork as a primary fix rather than as an attachment on top of a conventional roof. In addition surplus electricity is routed to a home battery pack rather than being fed into the national supply grid.

The photos look very realistic. I think he's onto something. Definitely the way to go if the system can be shown to be economically viable.

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Neil Gardner

Oct 29, 2016 at 21:30

It is very disappointing that the Government are withdrawing the subsidy for solar panels. However the only point I would make about Hotrod's article is that the home battery pack he mentions is not, I understand from the specialist companies, an economic option at present because of size, weight and expense. When technology - that is ENGINEERS - solve this problem, then it will be a great way to supply your home energy needs.

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Stephen B.

Oct 30, 2016 at 10:16

The big infrastructure projects won't be started for many years at least - in fact the end of crossrail and electrification of the GWR may reduce spend in the next few years. Is there anyone more involved with design and planning? Alternatively there could perhaps be a pot of money for small-scale projects, e.g. road junction improvements.

On power, if we move towards electric cars the total generating capacity will need to increase substantially, and we need some baseload generation that doesn't vary unpredictably. That needs to be either nuclear or gas with carbon capture, the latter being so far unproven.

It is also the case that solar power is now a disruptive technology - costs have fallen very fast and it's now getting competitive with gas even without subsidy. However it seems hard to predict how it will develop or who will benefit.

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Stephen B.

Oct 30, 2016 at 10:24

By the way, as an example I live near the site of a possible new small railway station which has been on the council's "to do" list for about 20 years but which has never found a budget to go ahead. Something like that could presumably be built rather quickly if money was provided.

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Neil Gardner

Oct 30, 2016 at 11:48

Fracking to produce home grown gas, dare I say it, could be a growth industry as it has become in the US. Unsure which companies are involved but somebody will know I'm sure. Producing our own gas is surely preferable to relying on the dodgy Russians to supply us.

A decision has been made on the third runway for Heathrow at long last, some of the major UK civils contractors will be involved together with a number of smaller subcontractors. Wherever the runway goes there will be an environmental cost but the business will eventually go elsewhere if not built at Heathrow with a cost to jobs and the economy.

Tidal power- the UK is very well placed with our huge tidal ranges. It was a huge disappoint to me that the Severn Barrage never got off the ground - we wouldn't have needed Hinckley if the Barrage had gone ahead - but at least there are some smaller schemes around South Wales that are well advanced at the planning stage. These will again end up with UK civils contractors in joint ventures with foreign specialists.

High speed rail !! Another major project.

Stephen B (above) has a point that these projects have all got to get through the Planning process which quite rightly may take time.

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Michael Grimes

Oct 30, 2016 at 13:41

First State global lised is 42% invested in US and less than 10% in all other countries so just thinkinhg about UK and its tendency to block/stop/start majpr projects not to mention cost and time overruns gives a better balance I think

But can anyone explain the reasons for the different classes of First State units being so different in price?

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Hotrod

Oct 30, 2016 at 13:50

@Neil Gardner

As I understand it, the first licence to date for commercial development of shale gas in the Lancashire field has been awarded to a consortium lead by Cuadrilla Resources, with partners, A J Lucas, and Riverstone Holdings LLC (all American) together with fourth partner Centrica Plc (British Gas)

Incidentally UK does not directly import any gas from the Russian Federation. We have a pipeline direct from the Norwegian Gas Fields with a contract to supply for the next forty years. Also the Norwegians have said that it would be feasible to lay an electricity cable to UK from their hydro-electric plants. Seems highly improbable though because of the power loss over such a distance.

There is another way to look for efficiencies. Before UK house wiring was standardised with 13amp ring mains, dual circuits were used: 15amp and 5amp. It occurs to me that some rooms in a lot of houses do not need anymore than a 5amp supply at 230 volts. Considering many of the gadgets we use run on 9 to 14 volts, a 230 volt supply seems a bit OTT.

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